TD Ameritrade (NYSE:AMTD) reported its third fiscal quarter earnings on July 22. In line with our expectations, the revenue generated by Ameritrade’s asset-based business grew by 12% year-on-year (y-o-y) to $430 million, while low trading volumes kept trading commission revenues flat over the prior year quarter at $317 million. As a result, the brokerage posted a mild 5% y-o-y increase in net revenues to $763 million. 
Although most of the expenses incurred by the brokerage are fixed in nature, its employee compensation and benefits expenses rose by over 7% y-o-y in the June quarter, which the company attributed to consulting work and certain advertising projects undertaken. These one-time expenses kept the operating margin flat over the prior year quarter. Going forward, the company does not expect to incur these expenses in its fourth fiscal quarter, which is likely to improve margins. Given that most expenses incurred by brokerages are primarily fixed in nature, growth in net revenues is likely to directly impact bottom line growth.
We have a $33 price estimate for Ameritrade’s stock, which is slightly higher than the current market price.
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Sustained Growth From Asset-Based Revenues
Revenues generated by interest on client balances grew by over 24% y-o-y to $149 million in the quarter. A similar growth rate was observed in the previous quarter as well. Client balances at the end of the quarter stood at $19.1 billion – almost 20% more than in the year ago period. The average balances in the first half of the year are higher than the company’s projection of $17-18 billion from the end of its previous fiscal year. 
Continuing the trend from the March quarter, revenues generated by Ameritrade on the fees charged for its services on money market mutual funds and other mutual funds grew by over 21% to $79 million in Q3. The fees are charged as a percentage of the client asset balances. The company successfully added $13.4 billion in net new client assets during the quarter to take its total client asset balance to $138.5 billion. This was a strong positive for the company since the June quarter is typically challenging to gather client assets owing to tax season outflows. Going forward, we expect the company to continue to attract clients at similar rates through the end of its fiscal year.
Revenues From IDA Balances and Trading Commissions Remain Subdued
In the last few quarters, the company’s insured deposit account (IDA) assets have been somewhat flat at about $72-73 billion. IDA balances stayed at around similar levels through the June quarter as well, but were still 6% higher than the prior year quarter. However, the y-o-y increase in IDA balances was offset by a decline in the net yield by 5 basis points over the year ago period. Consequently, the revenues generated by interest on IDA balances remained flat sequentially and annually at around $200 million.  We expect the yield on these assets to bottom out this year and gradually increase thereafter since the Fed has initiated its QE tapering program. Looking ahead, we expect the low yield on IDAs to continue for remainder of the year.
Ameritrade’s daily average revenue trades (DARTs) sequentially increased in each of the three quarters beginning July 2013 – from about 380,000 in Q4 FY 2013 to 492,000 in the second fiscal quarter of 2014. However, Ameritrade’s DARTs declined to 401,000 for the June quarter. Although this was a nearly 20% fall from the previous quarter, the figure was flat over the June quarter in 2013. Ameritrade realized a slightly lower average revenue per trade compared to prior year quarter, implying a 1% decline in trading revenues to $317 million. Despite a slight dip in trading volumes in the last couple of months, we forecast the average trades per account to grow by over 5% to 17.5 trades through 2014.
According to our analysis, the company’s adjusted EBITDA margin improved by only about 14 basis points over the prior year quarter to 47.4% in Q3 FY 2014. Comparatively, the adjusted EBITDA margin improved by over 150 basis points in the previous quarter. The slight decline in trading volumes during the quarter was partially responsible for keeping margins nearly flat. A similar trend was witnessed in competing brokerage Charles Schwab’s (NYSE:SCHW) recent earnings report. We currently forecast Ameritrade’s full year EBITDA margin to be over 48% in 2014. A rise in trading volumes in the latter half of the calendar year could help the company post even healthier margins than our forecasts.Notes: